What are secondaries and how do they impact employees?

What are secondary share sales?

Secondary share sales or secondaries, are transactions in which existing shareholders of a private company sell their shares to other investors, rather than the company issuing new shares. Secondaries typically occur in late-stage startups or private companies, allowing early investors, employees, or founders to liquidate some of their holdings before an initial public offering (IPO) or acquisition. These secondary transactions usually occur as part of funding rounds or investments but are also carried out on secondary markets.

How do secondaries work?

Secondary transactions generally involve a buyer, a seller, and sometimes an intermediary or a secondary market platform facilitating the trade. In theory, the process begins when a shareholder, such as an employee or early investor, seeks to sell their shares. However, in reality the start of a secondary share sale is most commonly driven by companies themselves. Similarly to primary investments potential buyers, often institutional investors, private equity firms, or other accredited investors, negotiate pricing based on the company’s valuation, growth potential, and market demand. This often happens as part of new investments, whereby a company may offer new shares and opportunities for existing shareholders to sell, as part of the total investment round.

Once terms are agreed upon, the company typically must approve the transaction, as many private companies have restrictions on share transfers. The sale is then executed, and ownership of the shares is transferred to the new investor. Most companies offer structured secondary programs, coordinating and facilitating the sale of shares to ensure compliance and alignment with corporate policies. 

Why are secondaries more popular now than before?

Secondaries have gained traction due to several factors. First, companies are staying private longer, delaying IPOs in favour of extended private funding rounds. This has led to pent-up demand from employees and early investors seeking liquidity before an exit event. Success stories of the past tech booms have left employees feeling stuck in an equity cycle, where in some cases shares can expire, or due to conditions of share plans be lost completely. Company remuneration packages that offer employee equity, could therefore be perceived as less valuable, due to the unlikely scenario where the value would be realised (turned into cash).

Additionally, economic uncertainty and volatile public markets have made private secondaries an attractive investment avenue for institutional investors, as they provide access to high-growth companies without the risks associated with public market fluctuations. The rise of dedicated secondary markets has also streamlined the process, making it easier for buyers and sellers to connect and complete transactions. The announcement and progress of PISCES in the UK only increases the likelihood of future secondary share sales.

What is PISCES?

PISCES is the abbreviation for Private Intermittent Securities and Capital Exchange Systems, which is a framework that aims to support the creation of a regulated, efficient secondary marketplace. By providing clear pathways for liquidity without going public, PISCES is expected to bolster confidence in secondaries as a mechanism for both businesses and investors to operate. Over the next 6-12 months the UK government will release further information on the ongoing legal consultations and regulatory framework.

What impact can secondaries have on employees?

For employees, secondary share sales can be a valuable opportunity to unlock financial gains from their equity compensation. This liquidity can often have life-changing impacts on employees, which would usually be less likely to happen if reliant upon IPOs or acquisitions.

Despite secondaries providing an aternative liquidity option and strategic advantages, they also come with challenges. One major hurdle is eligibility criteria – many private companies restrict who can sell shares and under what conditions. Employees may be subject to vesting schedules, lock-up periods, or right-of-first-refusal (ROFR) clauses, which give the company or existing investors the first option to purchase shares before an external buyer. Companies can also set additional eligibility criteria at their discretion, such as only existing employees can participate in secondaries. This can be controversial, due to the fact it excludes early-stage employees who would otherwise see significant gains due to the growth businesses experience as startups.

Pricing can also be a concern, as secondary sales may occur at a discount compared to the most recent company valuation, particularly if demand is limited. Additionally, secondary sales can create conflicts among stakeholders, as differing motivations between early investors, employees, and new buyers can complicate negotiations.

Overall, secondaries provide a crucial liquidity mechanism in the private market ecosystem, benefiting employees, investors, and companies alike by offering flexibility and financial opportunities ahead of traditional exit events. A well-structured secondary sale can help attract and retain talent by allowing employees to realise some financial benefits from their equity, which they may not experience if awaiting traditional liquidity events.

Should my company consider a secondary share sale?

Our latest State of Equity report revealed that 77.8% of businesses were either very likely or somewhat likely to run a secondary in the next 12 months. Companies that typically consider secondary share sales are late-stage startups or private companies with strong growth and high investor interest. These firms often have employees or early investors who seek liquidity before an IPO or acquisition, but they are not the perfect option for all companies.

The primary objectives of a secondary sale can include offering liquidity to employees, enabling early investors to exit, and maintaining a stable cap table by transferring shares to long-term investors. Additionally, some companies use secondaries to align shareholder interests, reduce pressure for a public listing, or bring in strategic investors who can add value beyond capital. Companies considering a secondary share sale should ensure they have clear policies, legal support, and a structured process to manage the secondary transaction effectively. Equity management software can help ease the administrative burden of all liquidity events alongside managing financial reporting requirements.